If you own a family business and you plan that your children will continue it, you have to act now. If you do not, you risk that when you and your spouse die, the business may be sold or liquidated to pay estate taxes. It happens all too often, yet usually can be avoided by careful planning.
Congress is expected to dig deeper into the assets of estates in its continuing search for increased federal revenue. With America's population growing older and wealthier, estates obviously are a rich source for new tax money, waiting to be mined. Nor is the fact that estate taxes already are huge likely to stop Congress. While the marital deduction protects spouses, there is no provision for a couple's heirs.
To deal with the problem, you will need the services of an estate planner, possibly working in tandem with your lawyer and financial advisers. The introduction of survivorship whole life insurance a decade ago now makes it possible to plan for estate taxes, says Howard Cowan of Cowan Financial Group, New York City. The policy pays off at the death of the second of two insured individuals. If these are husband and wife, the insurance proceeds are available when estate taxes are due.
Cowan relates the situation of a business owner with three children. The parents wanted to provide that the child in the business would obtain ownership of the business; the second, a doctor, would get the family vacation home; other assets would provide supplemental income for the third child, a teacher. Cowan's solution: a comprehensive plan which started a transfer of ownership to the child in the business, created an insurance rTC trust for the teacher (and his children) and paid for estate taxes with survivorship whole life insurance.
Frequently, however, business planning bogs down because of the personalities involved. "It's more difficult to structure the plan when there are several younger family members involved in the business," says Gerald Morlitz, a lawyer specializing in estate planning with Cowan Financial Group. "It's important to analyze their personal objectives and the importance of each of the children to the business. The need is to balance their competing interests without alienating one of them."
This involves discussions with the family as a group, and with each family member in the business. Cowan recommends giving stock to the children in order to take advantage of the gift tax annual exclusion, coupled with a shareholder's agreement that defines the rights of each of the shareholders. He cautions the parents not to give up voting control before they are ready to retire. Cowan suggests:
* Make certain that the stock cannot be transferred to anyone outside the family unless there is total agreement.
* Make sure that one child will ultimately receive voting control. A 50/50 split generally creates a problem.
* Create restrictions in the shareholders' agreement that provide rights to the child who does not eventually obtain voting control.
* Provide for the death of a child prior to the death of the parent. In a family business it can be devastating. Parents who gave stock to a child don't want to be told by a "child-in-law" how to run the business. Nor should the assets given to a child come back to the parents to be included in their estate.
Once family liquidity needs and succession planning are addressed, the appropriate funding can be accomplished. Frequently, this means life insurance. It's important that the life insurance proceeds be kept out of the taxable estate, says Morlitz.